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Market Efficiency

Market Efficiency. The Efficient Market Hypothesis: Pros, Cons, Questions. Market Efficiency (Fama 1). A market in which prices always "fully reflect" all available information is called "efficient." (383-384)

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Market Efficiency

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  1. Market Efficiency The Efficient Market Hypothesis: Pros, Cons, Questions

  2. Market Efficiency (Fama 1) • A market in which prices always "fully reflect" all available information is called "efficient." (383-384) • The definitional statement that in an efficient market prices "fully reflect" available information is so general that it has no empirically testable implications. Fama, Eugene F. "Efficient Capital Markets: A Review of Theory and Empirical Work," J. of Finance, V. 25, May 1970

  3. Market Efficiency (Fama 2) • All the empirical research on the theory of efficient markets has been concerned with whether prices "fully reflect“ particular subsets of available information.

  4. Market Efficiency (Fama 3) • Though we shall argue that the model stands up rather well to the data, it is obviously an extreme null hypothesis. And, like any other extreme null hypothesis, we do not expect it to be literally true.

  5. Market Efficiency (Fama 4) • The categorization of the tests into weak, semi-strong, and strong forms will serve the useful purpose of allowing us to pinpoint the level of information at which the hypothesis breaks down.

  6. Views on EMT (1) • "...the stock market quickly and accurately impacts into the price of a given company's securities everything that is known about the about the company. Here it is worth emphasizing that there is not a single work of any significance that contradicts the notion of the efficient market." Henry G. Manne, 1985

  7. Views on EMT (2) • In my opinion, the continuous 63-year arbitrage experience of Graham-Newman-Buffett Partnership illustrates just how foolish EMT is. ... unleveraged returns averaged 20% ...vs. 10% for the general market. (1988 Berkshire Hathaway Annual Report, p. 39)

  8. Views on EMT (3) • "This argument for the efficient markets hypothesis represents one of the most remarkable errors in the history of economic thought. It is remarkable in the immediacy of its logical error and in the sweep and implications of its conclusions."Yale Economist, Robert J. Shiller, 1984 (also authored, "Irrational Exuberance," 2000)

  9. Views on EMT (4) • "In any case, the pathetically inefficient market doesn't seem to have a clue as to what is going on. (135) Haugen, Robert, "The New Finance: The Case Against Efficient Markets," Prentice Hall (1985) (Haugen's comments are based on Fama and French, "The Cross-section of Expected Stock Returns," JF, June 1992)

  10. Jensen (1) • The takeover process penalizes incompetent or self-serving managers whose actions have lowered the market price of their corporation's stock. (112) Jensen, Michael, "Takeovers: folklore and science," HBR Nov-Dec '84

  11. Jensen (2) • Evidence shows that market prices incorporate all current public information about future CF’s and the value of individual assets in an unbiased way. Prices change, of course, in response to new information about individual assets. But because market prices are efficient the new information is equally likely to cause them to decrease or increase … Positive stock price changes, then, indicate a rise in the total profitability of the merged companies. (112) Jensen, Michael, "Takeovers: folklore and science," HBR Nov-Dec '84

  12. Prof. James Tobin Takeover mania, motivated by egregious undervaluations, is testimony to the failure of the market on this fundamental valuation criterion of efficiency... Takeovers serve a useful function if they bring prices closer to fundamental values. But the fact that markets fail to do so on their own is serious indictment of their efficiency. Tobin, J. "On the Efficiency of the Financial System," Hirsch Memorial Lecture, New York, N.Y., May 15, 1984, published in Lloyd's Bank Review, July, 1984. 1-14 (p. 6)

  13. Jim Tobin, CEO, BSX (1) • Q.Guidant was supposed to fuel the company’s growth. But if I had bought $1,000 worth of Boston Scientific stock a year ago, I'd have $750 now. What do you tell the shareholders who have stuck with you?Interview by Stephen Heuser, B. Globe, 1/28/07

  14. Jim Tobin, CEO, BSX (2) • A. I'm not quite sure why the market has been so negative. I mean, the idea that you could judge a transforming acquisition of this nature, which changes the company so fundamentally, on six or nine months of performance is just silly. • Everybody's going to look back, probably a year or a year and a half from now, and say, "Wow, what a smart thing for them to have done." In the meantime there are slings and arrows.   

  15. Jim Tobin, CEO, BSX (3) • Q. For instance, Fortune magazine called this the second-worst corporate deal in history. • A. Time will ultimately show that this was exactly what we thought it was when we did it -- an opportunity to diversify in the cardiovascular space that we know well, and to give ourselves two ways to grow.

  16. Precarious Predictions (1) • "Everything that can be invented has been invented."Charles H. Duell, Director of U.S. Patent Office, 1899

  17. Precarious Predictions (2) • "Who the hell wants to hear actors talk?“ Harry Warner, Warner Bros. Pictures, c. 1927 • "Sensible and responsible women do not want to vote." Grover Cleveland, 1905

  18. Precarious Predictions (3) • "There is no likelihood man can ever tap the power of the atom." Robert Milliken, Nobel Prize in Physics, 1923 • "Heavier than air flying machines are impossible." Lord Kelvin, President, Royal Society, c.1895. (the Royal Society was the preeminent scientific organization of its time)

  19. Precarious Predictions (4) • "A late-1970's market research study commissioned by Bell Labs .. predicted a (cell phone) subscriber base of only 800,000 by (the year) 2000, and concluded there was no market at any price.'" "...by next year (2000) there will in fact be an estimated 80,000,000 subscribers in the U.S. alone.." WSJ, 8/23/99, A14, "Why Cell Phones Succeeded Where Iridium Failed"

  20. Precarious Predictions (5) • "In 1876, a Western Union internal memo predicted, this 'telephone" has too many shortcomings to be seriously considered as a means of communication." Esquire Magazine, January 2000, page 64

  21. Precarious Predictions (6) • "Stocks have reached what looks like a permanently high plateau." Irving Fischer, Yale Economics Prof., 1929 • "I think there is a world market for maybe five computers." Thomas Watson Sr., President of IBM, 1943

  22. Precarious Predictions (7) • ""With over 50 foreign cars already on sale here, the Japanese auto industry isn't likely to carve out a big slice of the US market." Business Week, August 2, 1968. • "We are probably nearing the limit of all we can know about astronomy." Simon Newcomb, astronomer, 1888.

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